Brussels, 06-07 June 2006
ETUC resolution on monetary policy, economic recovery, wage and labour market flexibility in the euro area
1. Background. The euro area is finding itself in a challenging economic and social situation:
- While business confidence indicators have shown improvement over recent months, the consensus amongst economic forecasters (IMF, Commission, OECD) is that growth will weaken again in 2007 and will remain too modest.
- Wage formation and collective bargaining institutions are under pressure from this poor economic performance. Nominal wage increases are extremely moderate and real wages are falling. In some member countries, concession bargaining is leading to important cuts in working conditions. Workers and wages in different countries are being played out against each other.
- Despite substantial wage cost control, headline inflation in the euro area is still above the 2% threshold. Besides continuing energy price shocks, ‘stubborn' inflation is caused by governments that initiate ‘tax push' inflation in an effort to keep deficits somewhat in line with the Stability Pact.
- Although the euro area is not a primary source of global imbalances, it risks having to shoulder a disproportionate share of the burden of global adjustment in case of a dollar crash.
- While depressed wage incomes do not deliver a basis for household consumption to grow strongly, economic policy is already withdrawing aggregate demand support on three different fronts at the same time: Fiscal policy is set to tighten, the euro's exchange rate is appreciating and, most importantly, the ECB is in the process of hiking interest rates. Markets and institutions expect interest rates to reach 3,3% beginning 2007, up by 130 base points in a little over one year's time.
- Meanwhile, the ECB seems to be in the business of promoting an agenda for structural reform that is at least partly inspired by the US model of a flexible labour market with very limited rights or protection for workers (lowering job protection, lowering social benefits, flexible wage formation on the enterprise level with a much reduced role for collective bargaining).
With the ECB deciding independently on interest rates and exchange market interventions, euro area monetary policy makers have an important key to economic success or failure at their disposal. The ECB can make (or break) the recovery and is in a position to set the economic and social structural reform agenda it wants to see respected before considering to keep delivering monetary support for the economy..
There is an urgent need for the ETUC and its affiliates to develop further a strategy to obtain euro area monetary and economic policies that support more and better jobs and do not represent a threat to workers' rights and wage and collective bargaining institutions. This resolution intends to constitute further the discussion on such a strategy.
2. Yes to price stability...
The ETUC supports the goal of price stability. High and volatile inflation is no basis upon which to build sustained growth and good employment performance. Relatively low and stable inflation on the other hand can reduce risk premiums in long term interest rates, thereby promoting investment and the economy's growth potential.
The ETUC also supports an agenda of structural reforms, provided these reforms:
- promote upwards (instead of downwards) flexibility to keep the European economy ahead of the competition from low wage economies;
- are equitable. Structural change creates both winners and losers and is only acceptable if policy minimizes the number of losers while compensating those that in the end remain disadvantage;
- are backed up by pro-active macro economic policies that bring the benefits of reform forward and avoid the economy from getting caught in a low confidence and low growth trap;
- are the subject of a real and effective social dialogue.
3. ... but no to the stability of the ‘economic graveyard'
The question is not whether price stability is desirable or not. The real question is how a central bank is trying to realise low inflation. There are two very different pathways to reach the objective of price stability:
- A central bank can fight inflation at all times and in all circumstances, even when inflationary risks have in fact disappeared. The central bank's strategy in this case is to realise a safety margin against a possible resurgence of inflation by having the economy operate systematically below potential. With such a monetary policy regime, cyclical upturns are modest and short-lived whereas cyclical downturns are deep and prolonged. Average growth over the entire time span of the business cycle is poor.
- By pursuing a symmetrical policy regime, a central bank can also fight inflation but without taking a heavy toll on economic growth. Monetary policy then reacts similarly, either when faced with inflationary danger or when inflation has disappeared and the real economy is in need of support. Such a symmetrical monetary policy regime has the important advantage of stabilising the economy. Economic activity is kept close to a level of activity that is compatible with low and stable inflation. Both cyclical upturns as well as downturns are kept under control, with the effect that growth is reasonably in upturns and recovers better from cyclical troughs. The aim of such a symmetrical policy regime is twofold: It is to maximize growth over the business cycle while at the same time maintaining low inflation.
4. Monetary policy in the euro area: More a-symmetrical than symmetrical
The European Treaty implicitly provides the ECB with the double mandate of fighting inflation and supporting the other objectives of the European Union such as growth, employment and social cohesion, provided price stability is not endangered.
The ECB however operates monetary policy on the basis of what it perceives to be a ‘single' mandate. The ECB repeatedly argues that the ‘best and only' way to contribute to growth is to guarantee price stability. In doing so, it provides a particular reading of the Treaty and reduces the double mandate of price stability and growth into a single mandate of price stability only. The related danger is that the ECB on the basis of this single mandate would implement and construct a monetary policy regime that only acts when price stability is threatened from the upward side but is standing idly by when growth and jobs are in danger and economic confidence is low.
This danger is indeed materialising itself to a certain extent. In practice, the euro area is the only region of the world that, after 5 years, still has to recover fully from the slump in economic growth. And euro area monetary policy is characterised by important differences depending on the fact whether the real economy or price stability is in trouble:
- The ECB acts quickly when growth is doing well or when an economic recovery seems to be in the making. In '99-2000, it doubled interest rates in the space of one year and it is now in the process of hiking interest rates again. But when the economy went down in 2001 and again in 2003, the ECB was reluctant to react and it took several quarters of a year before rates were brought down.
- When the euro falls on exchange markets, the ECB does not shy away from making exchange market interventions to prop up the euro by selling dollar reserves. However, when the euro appreciates sharply and undermines growth as it did end 2002-beginning 2003, no action is taken.
- When the level of economic activity is thought to be somewhat above potential (as it perhaps was to a limited extent in 2000), the ECB works actively to correct for this by reducing (effective) growth (temporarily) below potential. However, when the situation is the other way around, and characterised by cyclical unemployment and underutilisation of capital stock, the ECB is blocking a pattern of recovery that would bring growth (temporarily) above potential growth. Slack in the economy is thereby maintained and (cyclical) unemployment is kept high.
5. A bias against investment: Monetary policy is not neutral for long term growth potential
A monetary policy regime with a single focus on low inflation does not only come at the detriment of short-term growth over the business cycle, it also drags down the long term growth potential of the economy in a structural way: If the corporate sector realises that the monetary policy regime is constructed so as to keep aggregate demand below full capacity utilisation, the incentive to invest will suffer. Indeed, keeping aggregate demand close to full capacity is investor insurance against negative demand shocks and their persistence. In the absence of such insurance, investment will be riskier and corporations will invest less than otherwise would have been the case. Investments however build up the capital stock and are therefore an important determinant of long term growth potential. If the ECB has silently reduced its estimate of euro area potential growth from between 2% and 2.5% just a couple of years ago to just 2% at the moment, this has to do with the long slump in growth and investments since 2001 and the failure of macro economic and monetary policy to stabilise the business cycle and stage a full recovery from the slump.
6. ‘Beggar-thy-neighbour' and the bias against Social Europe
A monetary policy regime that is skewed against growth and investments also has important consequences for working conditions and Social Europe. Keeping the euro area economy in the doldrums has the effect of putting workers and trade unions in a tight spot. With macro economic policy providing insufficient aggregate demand for the euro area economy as a whole, member states are easily tempted to go for what they think to be a quick fix by engaging in competitive wage moderation and excessive labour market flexibility. If the European macro economic policy does not produce adequate aggregate demand, then the solution is to ‘renationalise' policy by trying to poach demand, investments and growth from neighbouring countries. Bad macro economic policy triggers the race to the social bottom.
Moreover, public statements coming from the ECB are worrying in this respect and confirm the impression that the ECB is actually welcoming European workers undercutting each other's pay and working conditions as a means to achieve what it is calling ‘competitive stability'. In doing so, the ECB fails to see that in a relatively closed economic area as the euro area, competitive wage moderation does not change relative competitive positions very much but does risk a further negative impact on euro area wide wages and household consumption, thereby deepening the problem of lack of overall aggregate demand.
7. How to get a European Central Bank fighting inflation as well as the lack of decent jobs?
The existing framework is one of a European Treaty giving a high degree of independence to the ECB, with the ECB reading its Treaty mandate in a narrow way (‘price stability is the best and only contribution of monetary policy to growth'). Taking these facts into account, the ETUC needs to follow a double track strategy:
- On the one hand, we need to provide the ECB with convincing signals that trade unions will take the objective of low inflation into account in the process of wage formation and collective bargaining, in order to avoid, amongst other things, second round effects from energy prices.
- On the other hand, when providing such anti-inflationary insurance to the ECB we must make sure to get growth-friendly monetary policy in return. As experience shows, there is a risk that wage formation delivers price stability while the ECB is continuing to base its monetary policy on the outdated presumption that wage behaviour did not structurally change. The result of this is inadequate demand, and disappointing growth and investment performance.
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Concrete proposals for such a ‘double track' agenda:}}
- Strengthening the Macro Economic Dialogue at European and national level. This dialogue is the only forum where all policy makers, including the ECB, are present. This provides an opportunity and the ETUC, together with its affiliates, should increase their involvement in it. At the same time, extending this dialogue to national levels could also be helpful to increase its practical relevance.
• Euro area level policy dialogue. As described in this resolution, substantially improving the coordination of wage, fiscal and monetary policies is particularly important for the euro area. A closer policy dialogue at the level of the euro area should be pursued by organizing twice-yearly hearings of European social partners with the euro group of finance ministers.
• Strengthening the coordination of collective bargaining policies. The work of the ETUC collective bargaining committee should continue on the basis of the guideline of wages ‘orienting themselves on the sum of inflation and productivity'.
• Closer follow-up of collective bargaining policies inside the euro area. Bargaining and wage trends inside the euro area need to be monitored closely with the aim of preventing nominal wage cuts spreading through concessional and/or decentralised bargaining. Analysis showing that wage bargaining does not jeopardize low inflation needs to be communicated clearly to the ECB.
• Better coordination of fiscal policies inside the euro area. The euro area level should also be used to coordinate fiscal policy in a better way. Leeway offered by the reform of the Stability Pact should be used to draw up national ‘investment for recovery' plans which are modulated in function of the situation in each economy. With some member states investing in recovery by accepting higher than planned deficits, and with other member states in a better economic position and thus able to reduce deficits more than planned, the impact on the average euro area deficit of additional investments could be somewhat limited. To focus the ECB's attention on the fact that the average deficit in the euro area is still below 3% (and to avoid the reaction of monetary restraint) the whole euro area wide public budget should be taken into consideration.
• Better coordination of indirect tax policy inside the euro area. Hikes in indirect taxes and administrative prices are keeping average euro area inflation over 2%. To avoid giving the ECB the alibi of ‘stubborn inflation' warranting a withdrawal of monetary support from the recovery, the ETUC urges the finance ministers to address this issue and to coordinate indirect tax policies in a better way so that systematic effects on euro area inflation are minimized.
• Making use of the democratic force of public opinion. In contrast with the claims of the ECB, European citizens are much more concerned with the lack of decent jobs and with the threats of structural reforms to social systems compared with their anxieties over inflation. This presents an opportunity for the ETUC to introduce into public opinion reasoned and well balanced arguments, analysis and reports which point to the need for balanced monetary policies.
• European Social Dialogue and the Joint working program. More common opinions should be sought with European employer organisations on the issue of balanced macro economic and monetary policies. The new working program of European social partners presents an opportunity to use the discussion on ‘flex-security' (easier adaptability of a secure work force) as a leverage for growth- and job-friendly macro economic policies (effective and sufficient new job offers).